Universal Steel Co. v. Comm'r of Internal Revenue

• Decision Date: 22 August 1945
• Docket Number: Docket No. 4546.
• Parties: THE UNIVERSAL STEEL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

5 T.C. 627

THE UNIVERSAL STEEL COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 4546.

Tax Court of the United States.

Promulgated August 22, 1945.

1. The proper amounts of compensation for petitioner's general manager and a salesman for the year 1941, determined.

2. The facts of record do not justify the imposition of the surtax under the provisions of section 102, Internal Revenue Code.

L. F. Loux, Esq., for the petitioner.

Lawrence R. Bloomenthal, Esq., for the respondent.

The respondent determined deficiencies in the petitioner's taxes as follows:

+-----------------------------------------------+
                ¦Tax                          ¦1940   ¦1941     ¦
                +-----------------------------+-------+---------¦
                ¦Income                       ¦$625.82¦         ¦
                +-----------------------------+-------+---------¦
                ¦Income, sections 13 and 15   ¦       ¦$4,158.29¦
                +-----------------------------+-------+---------¦
                ¦Income, section 102 (surtax) ¦       ¦41,380.07¦
                +-----------------------------+-------+---------¦
                ¦Declared value excess profits¦236.49 ¦2,086.27 ¦
                +-----------------------------+-------+---------¦
                ¦Excess profits               ¦653.77 ¦16,110.16¦
                +-----------------------------------------------+
                

Various issues were raised and abandoned. The remaining issues are:

1. The deductibility of $15,400 as a part of the compensation paid to Harry Resnick, general manager, for services rendered during 1941.

2. The deductibility of $14,000 as a part of the compensation paid to E. J. Shapiro, salesman, for services rendered during 1941.

3. The propriety of imposing a surtax upon the petitioner's income for the year 1941, pursuant to the provisions of section 102, Internal Revenue Code.

FINDINGS OF FACT.

The petitioner is a corporation, organized in December 1925 under Ohio laws, with its principal office in Cleveland, Ohio. It filed its returns for the taxable years with the collector of internal revenue for the eighteenth district at Cleveland, Ohio.

The petitioner has a capital of $100,000, represented by 1,000 shares of common stock. Its stock has been held primarily by its incorporators. During the taxable years Harry Resnick owned 238 shares, a partnership known as the Columbia Iron & Metal Co. (hereinafter called Columbia), and its nominees owned 720 shares, and two individuals owned the remaining 42 shares. The partnership of Columbia was composed of J. Miller; his two sons, Alexander Miller and Lewis Miller; and his wife, Ida Miller, each having a share of 25 percent of the net profits after deducting the salaries of the active partners. The petitioner's board of directors is composed of Joseph Miller, president; Alexander Miller, vice president; Lewis Miller, treasurer; and Harry Resnick, secretary and general manager.

The petitioner is engaged in the business of warehousing, processing, and distributing steel sheets, strip steel, and such steel as is to be formed and stamped. It does not handle scrap steel (except such scrap as is made by it), bars, rods or ingots. The major portion of its business is in sheet steel.

The petitioner rents its building, a warehouse 60 feet by 360 feet and 120 feet high, equipped with three 10-ton overhead cranes. It must pay for repairs and maintenance. Petitioner installed four shearing machines and testing apparatus. The offices are separate and apart from the warehouse. The petitioner must keep the warehouse dry and maintain an even temperature therein in order to prevent rust. Rusted material is sometimes reduced to scrap, having only salvage value.

From 60 percent to 65 percent of the petitioner's purchases are ‘rejects,‘ that is, a sheet with slight imperfections, due to uneven surface, off-gauge width and thickness, bad drawing, improper rolling or shearing, and other such defects, or to an excess of mill run stock. During the taxable years the petitioner maintained substantial inventories.

In order to supply customers with the required sizes the petitioner cuts sheets or plates accordingly, using four large shears, overhead cranes, testing machines, and other equipment. For the purpose of maintaining its favorable contacts with the large steel mills in its locality, the petitioner is compelled to take as a lot ‘rejects‘ of assorted sizes and gauges as selected and offered by the mill. Consequently, sizes not in current demand are included in the petitioner's purchases, thus enlarging its inventory by the excess purchases.

Harry Resnick, as general manager, supervises everything in connection with the petitioner's business, from buying the steel to selling its products and controlling its salesmen. He is in full charge of and directs the petitioner's activities of all kinds and character. He is regarded as the operating head of the business, to which he devotes all of his time and attention.

Prior to 1941 the petitioner's principal business was in light steel sold to manufacturers of kitchen utensils, electrical appliances, toys, and lighter automobile parts. In 1941 there were no controls by the United States Government on the manufacture, sale, or use of steel. Sales dropped in 1942, due primarily to the establishment of Government controls.

The petitioner guarantees the steel sold by it. It has not been necessary to spend much money on such guarantees. In a few instances defective stock has been replaced. No reserve is set up on the petitioner's books to take care of its obligations under such guarantee. In 1941 the cost of replacement of defective goods was several thousand dollars.

The petitioner conducts its business in the same building as Columbia. The two concerns have separate offices. The building is owned by the Miller family, the partners in Columbia. There is no business relation between Columbia and the petitioner. The members of the Miller family are not related to Resnick.

Harry Resnick was one of the organizers of the petitioner in 1925, when he was about 39 years of age. Prior to 1925 he had had some 22 years of experience in the business and management of concerns engaged in the scrap iron and steel business.

Resnick joined with the Millers to organize the petitioner in order to ‘get into business for himself.‘ He started with a salary of $50 a week. The salary from his previous employer was $12,800 when he left to form the petitioner corporation.

In 1928 Resnick's salary from the petitioner was $9,700 a year. In the following year he reduced it to $5,860, approximately where it remained until 1936, when it was increased to $10,000. In 1937, 1938, and 1939 his salary was $10,400, and in 1940, $15,400. It was the understanding between Resnick and the Millers that his salary would be increased when the petitioner's financial condition would so warrant, although no specific amount was fixed.

In 1941 the petitioner's board of directors voted to give Resnick a bonus of $30,000. The resolution of the board of directors was as follows:

MINUTES OF A SPECIAL MEETING OF THE DIRECTORS OF THE UNIVERSAL STEEL COMPANY HELD AT THE OFFICE OF THE COMPANY AT 6600 GRANT AVENUE, CLEVELAND, OHIO, ON SATURDAY, DECEMBER 20, 1941.

Mr. J. Miller, President, acted as Chairman of the meeting and H. Resnick as Secretary. Messrs. Lewis Miller and Alex Miller, the other directors, were present.

After an examination of the financial affairs of the Company and a determination that the earned surplus was sufficient for the purpose, it was moved by Lewis Miller that a dividend amounting to $8.00 per share be paid forthwith to all shareholders of record this date. This motion was seconded by Alex Miller and carried by unanimous vote.

The Chairman then suggested that in view of the fact that sales during the year 1941 were approximately three times as great as in the previous year, occasioned largely by the extraordinary efforts of Mr. Harry Resnick and partially to the efforts of salesmen, additional compensation to them was in order. Lewis Miller then moved that the sum of $48,250.00 be set aside for the payment of bonuses, that out of said sum $30,000 be paid as additional compensation to Harry Resnick and $18,250.00 be paid to various salesmen selected by Harry Resnick and in amounts determined by him. This motion was seconded by Alex Miller and carried by unanimous vote.

There being no further business before the meeting, same was duly adjourned.

The Millers had rejected requests for salary adjustments in prior years because they were dissatisfied with Resnick's actions in granting credit to the Rochester Manufacturing Co. and others, with his refusal to scrap a large amount of ‘old inventory,‘ consisting of accumulated sheets in bad condition, and with a continuing debt, running as high as $50,000, due to Columbia.

In 1939 the Rochester Manufacturing Co. account, at times as much as $32,000, was settled with a loss of about $1,100. By 1940 the petitioner paid all of its debts to Columbia and the ‘old inventory‘ was sold at a profit. In that year, for the first time in the history of petitioner, it was out of debt.

In 1941 the Millers had no further excuse for objecting to the payment of a higher salary to Resnick. Resnick's salary for 1941 was $10,400. The total of salaries of officers in 1941 was $50,800. The amount of $30,000 so paid by the petitioner was fair additional compensation for Resnick's services for the taxable year.

E. J. Shapiro, a graduate of Ohio State University, was employed by the petitioner during the latter part of 1939. He is not related to any of the petitioner's officers and he was never an officer thereof. Resnick needed a salesman to secure new customers for the petitioner's products. He trained Shapiro for about six months in the office and plant and sent him out with other salesmen for three months. Shapiro was then instructed to solicit new accounts and also to contact older trade. He was given the worst accounts by the petitioner for his own development and for the good of the company.

Resnick started...